IRVINE, CA—The retail sector has been weak in terms of transaction volume and pricing, and vacancy rates are higher than expected, Auction.com‘s EVP Rick Sharga tells GlobeSt.com. In fact, Sharga thinks the sector will soon be undergoing an immense structural change.
As GlobeSt.com reported last week, Auction.com reports a healthy outlook for commercial real estate markets, with all major sectors demonstrating year-over-year growth and widespread strength. According to the firm’s Q2 CRE Capital Markets Monitor Report, transaction metrics are trending in a positive direction, with deal volume and pricing shifting upward as cap rates and risk premiums decline.
There ae strengths and challenges in all sectors. We spoke with Sharga about the strengths of the apartment sector, what’s happening in industrial and the challenges awaiting the retail sector.
GlobeSt.com: Apartments are taking a smaller piece of the transaction-volume pie. Do you anticipate this continuing as some of the sectors that had been lagging—like office—strengthen?
Sharga: I do think office will continue to strengthen. I’m not sure if we’ll see the apartment sector lose too much ground. Personally, I’m more concerned about the retail sector, which might be on the verge of a structural change in the marketplace.
For decades, experts have predicted that online retailing will have an impact on the bricks-and-mortar retailer. As we’re coming out of the recession, we’re finally seeing online retail surpass previous numbers. We’ve had higher-than expected vacancy rates, and the sector has been weak in terms of transaction volume and pricing. We could be seeing a market shift from bricks-and-mortars to online. This is coupled with larger retailers falling on hard times. Sears and Staples are shutting a number of stores, and these are retailers with large operations vacating pretty significant square footage. So, it’s not necessarily that apartment transaction volume is that much heavier, but just that retail is that much weaker.
That said, we saw last week that the majority of housing starts and the fastest-growing segment in housing was once again multifamily. There’s clearly a feeling in the marketplace that there’s going to be a need for more rental units, and this could drive transaction volume in the sector.
GlobeSt.com: How do you see industrial pricing trending as we move further into the decade?
Sharga: I think it’s likely to go up, partly because like office space, industrial is seeing technology requirements and design-flexibility requirements, and these make it more expensive. We will see more requirements for green properties, and there’s retrofitting involved. The potentially negative trend in the retail sector has helped the industrial sector, so there’s more need for industrial centers and warehouses for online retailers, and this demand could drive pricing. Hanging over us is the specter of higher interest rates—that’s the unknown variable in this equation. When interest rates go up—and how high—could dictate pricing trends for all these sectors, to a certain extent.
GlobeSt.com: Do you expect retail pricing to continue decreasing in the face of online shopping and smaller footprints?
Sharga: I think these things are going to challenge retail pricing for sure. And if we do wind up with a flood of available property on the market, it dampens the opportunity for pricing to come back in the sector. If I had one concern about the pricing sector, it would be that one. Of course, local trends vary from market to market, but looking broadly across the country, that’s what we’ll be looking at.
GlobeSt.com: What are ‘risk premiums’ and why do they differ from hotels to apartments? Where do you see them heading for each category?
Sharga: They’re going to vary from sector to sector, and they’re a reflection on what investors are willing to pay relative to what they could generate risk free. The higher the potential return, the higher the risk premium they’re willing to absorb. It’s where the investors see the greater long-term opportunities. Apartments have outpaced hotel space on a quarter-over-quarter and year-over-year basis, although hotels was one of the strongest sectors. The question is, how much room does that sector have left for expansion?